Having lots of cash in the bank is the easiest way to avoid your business going under. When you have cash, it’s much easier to pay your employees, meet debt obligations, and keep the lights on. In most cases, being short of cash isn’t a result of poor sales. It’s a result of poor planning. Forecasting your company’s cash flow is critical to maintaining positive cash flow. But, changes in variables, timing, and assumptions can cause inaccuracies in your forecasting.
Common Cash Flow Forecasting Mistakes
An accurate cash flow forecast is key to making the right business decisions; however, few are confident with their accuracy. Kyriba surveyed several treasury professionals, and their responses reflected this truth: Cash flow forecasts are essential but lack accuracy.
Here is a breakdown of how business leaders usually feel regarding their forecasts:
- Highly accurate (almost no variance): 0%
- Accurate (some variance, but not significant): 32%
- Somewhat accurate (some significant variances): 53%
- Very inaccurate (major variances): 8%
- Variances aren’t analyzed: 8%
Two mistakes that reduce cash flow forecasting accuracy are:
- Lack of Updating the Yearly Budget Regularly
- Lack of Communication To and From the Accounting Department
Start with reviewing your budget and communicating immediate changes to your accounting department moving forward. With that in mind, let’s examine five ways to increase your company’s cash flow forecasting.
5 Ways to Increase Cash Flow Forecasting Accuracy
Every business has different goals, variables, sales, etc. Because of this, each company’s cash flow needs will be very different.
Forecasting happens more than once a year and should allow you to pivot when needed. So you need to ask yourself, “Is my cash flow forecast accurate?” In asking that question, you will delve into the following areas to determine how accurate your cash flow forecast is.
Here are five suggestions that can help you determine your cash flow forecasting accuracy:
- Have your department managers communicate routinely with the CFO.
- Department managers and directors have needs throughout the year. Each department establishes a budget at the beginning of the year. They operate within this budget, but departmental and company-wide needs may change.
- Changes to personnel, infrastructure, software needs, and more can change the budget. While sometimes small, these changes impact the forecast’s accuracy and should be communicated monthly to the CFO.
- Failure to accommodate for these changes can result in outdated budgets that can hold your company back. Communication is essential to the accuracy of the cash flow forecast. Your sales team plays a vital role in this communication by providing the accounting department with potential closes, sales updates, client retention, and more.
- Use sales numbers that are 90-95% accurate. When in doubt, lower your projections.
- Your sales team should only provide sales forecast numbers to place in the forecasting pipeline with a 90-95% close probability. Future sales numbers should be based on the year’s sales goals and updated based on conservative outcomes.
- For example, if the CEO is aware of a situation that will negatively impact sales, then this change in sales should be input into the forecast.
- Another common rule is that, when in doubt, you should lower your sales estimates. This isn’t because of a lack of faith in your product or sales team. Rather, it’s just best to plan for the worst even if you’re constantly hoping for the best.
- Keep your personnel sheet updated.
- Payroll accounts for a large portion of all business expenses. If a department grows faster than expected and needs to hire a new employee then this projection should be updated in the cash flow forecast to show the impact on the future.
- Future cash flow is also a good indicator of whether the company can support and pay the new hire.
- Also, check your bonus and commissions within your personnel sheet as well. If you regularly give your employees a bonus during the holidays, you will want to have this in the forecast.
- Ensure that your cash inflows and outflows are correctly identified.
- Cash inflows are based on when the payment for sales and services are collected.
- For example, if a company invoices after a project is complete, the company needs to reflect the payment time in its cash flow forecast. This may be different than how the sale is recorded in the profit and loss statement.
- Mistakes in outflow forecasting happen when companies don’t consider both fixed and variable expenses correctly. Variable costs change with your production and sales volume.
Update your forecasts to include seasonal changes.
Take a look at the following areas of your forecast:
- Revenue
- Sales
- Expenses (variable and fixed)
- Payroll
Are these areas reflecting what you would normally expect at that time, given historical data? If the answer is no, then you have a problem. Ensure you take into account all these areas during your accounting team meetings. If something looks off, then address it and get to the bottom of why that number seems incorrect.
A miscalculation could be causing the inaccuracy, or it could be accurately forecasting a terrible outcome. If the result is awful, you can decide to pivot before it happens; this is the fantastic side of forecasting.
Your cash flow forecast accuracy will allow you to make decisions and observe the cash flow’s resulting impact.
While cash flow forecasting may be a challenging and lengthy task, the process will tell you how much you can expect to generate to fund future business expansions. You can also use the forecast to generate “what-if” scenarios for questions you may be pondering as a business owner.
You can run those scenarios without impacting the cash flow to see how your decisions would impact cash flow in the future. Your accounting team is a profit center. Without their expertise, guidance and understanding (especially in the area of cash flow analysis and forecasting), you would not be able to easily sleep well at night knowing your company is ready for the future.